Macro Man

Off To The Races

noreply@blogger.com (Macro Man) — Mon, 09 Nov 2009 08:39:00 +0000

On your marks...get set....go!

Markets are off to the races so far this morning, as all manner of risky assets on Macro Man's screens have roared higher. It almost feels as if markets, having successfully survived the murderer's row of event risks last week, exhaled over the weekend and decided that plan A (liquidity-driven uber-rally) wasn't so bad after all.

For if markets "wanted" to head lower, they surely could have. Friday's payroll report was an ugly one beneath the veneer of a largely in-line "number of jobs" figure. The household data, for example, was pretty appalling, continuing the divergence observed in this space on Friday. Sometimes, it's useful to look at data in its simplest form; readers are invited to reach their own conclusions as to what the chart below implies moving forwards.
Similarly, the latest Krishna Guha article with the impressive St. Louis Fed president, James Bullard, suggests at least some voters do not wish to repeat the mistakes of the not-too-distant past.

On some days, that perhaps might have been enough to send markets reeling. Not today, however, which is instructive. Perhaps markets are relieved that the G20 accomplished nothing of consequence? That Gordon Brown's proposal to tax ~~the very air you breathe~~ financial transactions received short shrift from Lil' Timmy?

Or have they been swayed by the IMF report that the US dollar is potentially being used as a funding currency? (A little-known codicil to the weekend report also noted that the sun would rise in the east, observed that ice cream is cold, and forecast that the Pittsburgh Pirates would not win next year's World Series.)

In any event, it is worth observing that among the star performers in recent days have been Asian currencies; the ADXY is nearly back to its October highs. Macro Man notes this because Asia was really the first "risk asset market" to roll over, a week before the fateful Guha article appeared in the FT on Octboer 23.
You don't have to be a chartist to think that after a healthy correction, if we make a new high then it really could be off to the races....

Random Shots

noreply@blogger.com (Macro Man) — Fri, 06 Nov 2009 08:55:00 +0000

You've heard of The Longest Yard. You've heard of The Longest Day. Well, this has been the longest week, given the barrage of significant releases, announcements, et al. We conclude today with US non-farm payrolls, after which Macro Man plans to relax over the weekend.

Anyhow, he doesn't have the energy to conjure a neat tie-in this morning...all he can manage is a collection of random thoughts:

* Very little (short of a positive print) would surprise Macro Man from today's payroll number. Last month's household data and the recent jobs hard to get measure from the consumer confidence survey would suggest risks are to the downside. Claims and the ISM employment figure would suggest risks to the upside. Throw in a dash of statistical hocus-pocus, and just about anything is possible. Jan Hatzius at Goldman has been, ahem, unusually accurate recently; for what it's worth, he's forecasting -200k and 9.9% on the u-rate...
* Is the equity pain trade for a melt-up? The most recent II survey showed a collapse in net bullishness back towards historical lows (excluding March.) Combined with the 30 level on VIX holding, Macro Man's left to wonder if the liquidity orgy is back on the cards. USD/KRW seems to think so....
* If you needed any convincing that this market is screwy, the dollar index ETFs should convince you. Wednesday saw an enormous amount of November call buying on the UUP (dollar bullish) ETF. As in, 320,000 lots enormous. Then yesterday, someone tried to engineer an enormous squeeze in the ETF, to the point where it ran out to shares to create! UUP soared 2% on a day when the dollar....didn't. You can see the effects of the squeeze on the chart below (depiciting UUP, the bearish UDN, and the underlying DXY.) So yesterday, you could bet on the $ going up, make an equal bet on the $ going down, and make money. Yeah, this market is rational....
* So yesterday, the BOE did more QE (£25 bio), JCT was more hawkish than expected (suggesting improved growth prospects and hinting at a not-too-distant embarking on an exit strategy)....and EUR/GBP goes nowhere on the day, net/net. Yeah, this market is rational....

* It has become a cliche (repeated in Macro Man's own FAQs) to recommend books like Reminiscences of a Stock Operator or Market Wizards to people looking to indoctrinate themselves into trading. But Macro Man is rapidly coming to the conclusion that re-reading those books is a mistake for someone with a mature investment strategy. It seems like every time that Macro Man does so, a cold streak immediately follows. Perhaps, subconsciously, it encourages the reader to deviate from their preferred methodology based on some "pearl of wisdom" contained in the books? Macro Man is curious if other experienced punters have found the same. (And yes, a couple of weekends ago, your author picked up Market Wizards to read while eating a sandwich for lunch...)

* Reader of the comments section have recently been treated to a, ahem, "vigorous" debate between "Gary" and "leftback" on a range of issues, including the differences between pension and hedge fund management. Macro Man is always bemused by the mutual contempt with which large real money guys and hedge fund guys often regard each other.

To the PF guy, the hedge fund guy manages a bit of loose change with the attention span of a gnat...and gets richly rewarded for it. Oh, and he doesn't have to worry about stuff like liability matching, long run return assumptions, or Jimmy Hoffa. To the HF guy, the pension fund guy has the ease of not marking to market or getting tinned/losing assets after a small cold streak. Responsibility for losses can be dispersed amongst the many heads around the committee table. Benchmarks are for sissies: it's all about absolute return, baby! (Well, except for 2008, natch...)

Unsurprisingly, there is some truth in these caricatures...but caricatures they nevertheless remain. Ironically, among the greatest PF/endowment managers are those that trade more like HFs. Jack Meyer, et al at Harvard managed a clip of capital that I assume most PF guys would concede was reasonable, but traded many of those assets much more tactically than most PF...with spectacular results.

Of course, they also got paid like HF managers...and some alumni decided that paying 8 figure salaries to a small group of people (who generated a decent chunk of the univeristy's operating budget, btw) was unacceptable.

And so Meyer, Samuels et. Al left, to be replaced by a group of successively cheaper, more real money-ish managers. And surprise....performance has gotten a lot worse! There is a lot more overlap in the Venn diagram of good PF and HF managers than most would believe....

QE or not QE? That is the question

noreply@blogger.com (Macro Man) — Thu, 05 Nov 2009 09:00:00 +0000

Dear Fed,

Macro Man speaks to a lot of well-informed, knowledgable punters. Many of you (collectively on the FOMC) know some of these very people. They are smart, and they spend a lot of time analyzing you and trying to understand your way of thinking.

And last night, after you changed this:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period

to this:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period

the interpretation of this group of well-informed observers ranged from "as dovish as it could be" to "man, that's pretty hawkish."

Please. I know Greenspan once said that if his meaning was clear, you hadn't understood him properly. But where did that get us? Seriously, one shouldn't need to employ a literary theorist to figure out what you're saying. Ditch the stupid word games and speak clearly. Compared to A students like the RBNZ:

In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010

and the Bank of Canada:

Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target

you collectively get a big fat F for your essay.

Sincerely, Macro Man

Given the opacity of the Fed's communication strategy (in terms of using blunt phrases to convey very nuanced shifts), is it any wonder that the market's reaction was as schizophrenic as it was?

And given that schizophrenia, is it any wonder that a "signal" trader like Macro Man is struggling amongst all the noise? Taking an introspective step backwards last night, Macro Man concluded that one of his primary problems is that he is reacting to short term price swings, rather than anticipating. The problem with reacting is two-fold: conviction is necessarily lower than it would be with a well-thought out macro view, and the lack of serial correlation leads to a lot of top-and-tailing. Macro Man has had enough.

Anyhow, the primary feature of the Fed's semiotic parlour game was the introduction to conditionality to the "extended period" clause. The first two conditions- the output gap and actual inflation- would not appear to merit tightening for the foreseeable future. The third- inflation expectations- could prove to be a bit more problematic, though 10 year breakevens are still below their pre-crisis levels. Still, the recent normalization is striking!

QE or not QE? That is the question. Whether 'tis nobler in the mind to suffer the slings and arrows of outrageous banking, or to take arms against a sea of troubles, and buy Gilts to end them?
-Hamlet's Soliloquy, by the ~~Bard of Avon~~ Swerve of Lomard Street

The highlight of the day today will be the Bank of England's policy announcement at noon local time. An extension of QE has been widely bandied about in the press, particularly in the wake of the recent GDP shocker. Ex-MPC'er David Blanchflower certainly favours more; at this juncture there appears to be little firm consensus, however, with some shops calling for nowt and others calling for £50 bio more gilt buying, plus a cut in the reserve deposit rate. If the latter were enacted, one would presume that sterling would get trashed.

Whether the Bank should do more QE is, of course, another question: the GDP figures scream "yes!", but more forward looking indicators suggest a more positive trajectory for the economy.

Either way, there should be some fireworks. And let's not forget Jean-Claude, ostensibly relegated to the role of bit-part actor in this week's drama, but always capable of stealing the show at his press conference. Needless to say, Macro Man isn't getting his hopes up for a spot of plain speaking there.....

Turnarounds

noreply@blogger.com (Macro Man) — Wed, 04 Nov 2009 08:34:00 +0000

It's been a shambolic start to what should ultimately prove to be a pretty important day. Macro Man normally catches a 6.33 am train from his local station into London Bridge; imagine his horror, therefore, when he opened his eyes this morning to discover the numbers "6:27" on his clock face.

After muttering the obligatory four-letter epithets under his breath, he sprang out of bed and raced through the shower at breakneck speed. If he hurried, he reckoned, he could just about make the 6.46 train which, while slower and considerably more crowded, nevertheless manages him to deposit him at London Bridge 20 minutes later than his normal service.

As he raced to get dressed, however, he heard an ominous rumbling from outside his window. This in turn prompted Mrs. Macro to spring out of bed, offering her own invective; the bins hadn't been put out and the dustmen were already outside. We dressed and jointly raced downstairs, with Macro Man not bothering to tie his shoes before springing out the door....only to find the garbage truck blocking his driveway.

"Which bins?" (recycling or rubbish?) shrieked Mrs Macro.

"Guys can you move I'm late to catch a train and I need to get out of here now!" bellowed Macro Man, in his best stream-of-consciousness technique.

Oh-so-slowly, the rubbish collectors backed the truck up, and Macro Man hopped into his trusty Golf and sped off towards the station, rolling down the window to offer a barely-awake wave to a disheveled Mrs. Macro, who'd managed to get the bins out in time. (Unbeknownst to Macro Man, Macro Boy the younger was, at roughly this time, slamming the door behind his mother, thereby locking her out for ten minutes.)

The station's only a couple of miles away, so after parking up and sprinting (with untied shoes!) to the platform, Macro Man improbably managed to get there at 6.39...enough time to queue for a coffee! In the annals of close morning shaves (in the figurative rather literal sense, naturally), this was close to a record turnaround from the bed to the station.

The rest of the journey, meanwhile, offered its own challenges; the later train is smaller and calls at more stations, so perhaps inevitably, Macro Man got stuck sitting next to some large-boned chap who felt it necessary to hold two large briefcases on his lap rather than stowing them in the luggage racks. His arrival at London Bridge reminded him of why he gets the early train; every ten minutes after 7 am appears to double the volume of passengers milling about the station.

By the time he fought his way to the platform of his connecting train, he was confronted by a mass of humanity commonly found only at major sporting events, the Muslim hajj, or Chinese job fairs. Imagine his shock and bemusement, meanwhile, when the first train to arrive on the platform was.....his usual 6.33 service!!! He isn't sure what happened to it (it wasn't on the board at his station at 6.40, so presumably arrrived and left at the normal time), but it looks like he was gonna be behind the 8-ball no matter what happened this morning. Sort of like the last couple weeks of trading, actually....

In any event, that rather verbose and tortured introduction was merely a way to inject the notion of "quick turnarounds" into today's post. For if Macro Man executed one this morning in gettting out of the house, so too, has gold in recent days, defying gravity (and the general strength of the dollar) to post fresh all time highs. It's up more than $60 in the last six trading sessions, spurred partially by yesterday's news of India taking down a 200-ton print from the IMF, but more clearly by real buying flow.

As is always the case with the yellow metal, there are a dozen stories and theories offered for its performance, and per the usual it is difficult to distinguish fact from fantasy. However, an Occam's Razor analysis might well suggest that someone is taking an (informed?) punt on either financial stability, the maintenance of globally easy liquidity conditions, or both. If the latter, in particular, one would have to posit that the dollar would come under renewed pressure after the Fed (unless punters wish to wait for payrolls).

The last 13 hours or so have also seen a fairly sharp turnaround in risk sentiment. Spoos are up a percent and half or so from the levels prevailing when Macro Man left the office yesterday. Earlier this week Macro Man observed that VIX around 30 was likely to be a critical juncture; for the time being, at least, it has helped staunch the equity market's losses. Similarly, Macro Man's proprietary risk index has recently gone back below zero after six months of risk-seeking readings. The next few trading sessions will likely determine whether this index bounces into year end or sustains a "proper" bout of sustaind risk aversion.
On Friday, September 11, the SPX closed at 1042.73. The following Monday, Macro Man created a reader poll on where the SPX would close at year end. The response was overwhelmingly bearish.

He'd like to repeat the exercise today. This space sometimes gets labeled as a "bearish blog", an appellation which Macro Man dislikes. His paramount interest is in getting things right (the signal, that is, rather than the noise), even if he doesn't always do so. In any event, he has detected a distinctly pro-risk attitude towards some of the punters with whom he speaks on occasion. So he'd like to take the market's temperature on a slightly more statisitically significant scale.

Where will the S&P 500 close the year?(survey software)

It's 10 am London time, and Macro Man's still feeling a touch groggy from his quick turnaround this morning. He can only hope, by the time he goes to bed, that his trading fortunes manage to execute a similarly impressive 180.

Hunting Season

noreply@blogger.com (Macro Man) — Tue, 03 Nov 2009 09:22:00 +0000

Yesterday was instructive, n'est-ce pas? The ISM was substantially stronger than exepected (OK, new orders dipped slightly, but employment rose sharply to exceed 50), equities popped sharply higher.....and then spent most the rest of the session melting away. Sometimes it's possible to over-intellectualize things: at the moment, stocks trade like they got 'em but they don't want 'em.

When Macro Man hears phrases like that, there's only one thing that pops into his head: hunting season. Flamingo hunting season. To be sure, flamingo-hunting has been in play for stuff like EUR/USD, ADXY, and broad indices for a couple of weeks. But now it looks like the hunters, having bagged their quota of big-game flamingos, have started poaching out-of-hours.

Macro Man wrote about Sunday night's ZAR/JPY carnage yesterday; last night saw the poachers go 2/2, as EUR/HUF was the victim of what is known in the trade as a "drive-by" stop loss run, which is an occupational hazard when you leave stops in illiquid pairs with NY spot desks.

More generally, taking a step back and observing the performance of the "naive" G10 carry basket (long the 3 high yielders, short the 3 low yielders), we can see that (unbelievably!), it has recouped nearly all of its "end of the world as we know it" losses. If you were fortunate enough to put this thing on close to the lows, you no doubt are feeling fine. But the very vehemence of the rebound would suggest that G10 carry is heavily posittioned. Add in the fact that AUD and NOK are especially beloved of reflationistas, and the potential downside for those currencies on a continued flamingo run would seem considerable.
And what of intra-equity market price action? Here, too, we observe an interesting dynamic. The chart below represents the relative performance of a basket of turds (some of whom don't currently exist [though their stocks are still listed], and the rest of whom wouldn't exist without government largesse) against the SPX. As you can see, there have been quite a few peaks and valleys over the year, with the relative outperformance in March and July/August looking like short-covering rallies in the turds.
Anecdotally, however, people have gone long these turds on the flimsiest of rationales, and now it appears to be going wrong. Indeed, the roll-over closely resembles that of June/early-July, a period which happened to coincide with quite a sharp downdraft in stocks.

It's hunting season, all right. How long the season lasts may depend on Chief Gamekeeper Bernanke tomorrow night- that is, assuming that the poachers follow the guidance laid down by the Fed. With so many flamingos turning into turkeys, however, there's probably no guarantees even after tomorrow night.

A Manute Bol Week

noreply@blogger.com (Macro Man) — Mon, 02 Nov 2009 07:54:00 +0000

It's a big, big, big week. Starting off with today's ISM (well, technically, starting off with yesterday's China PMI), we've got the Fed on Wednesday (the end of the extended period?), the BOE (more QE?) and ECB on Thursday, and of course payrolls on Friday. Throw in the odd corporate bankruptcy, an old-skool bank writedown, and the odd kleptocraric land-grab, and the only thing bigger than this week is 80's NBA player Manute Bol (pictured, left, with teammate Tyrone "Muggsy" Bogues.)

Manute, the "Dunkin' Dinka" from Sudan was, as you may well discern from his physique, something of a novelty player. His offensive skills were, well, offensive and he was a poor rebounder due to his lack of mass. He did excel in one area, however: blocking opponents' shots with his impossibly long arms. He even led the the league twice in that category.

Actually, the end of last week was a bit reminiscent of Manute as well. After the key breakdown in major indices on Wednesday, stocks appeared to execute a Manute-style rejection of the downmove on Thursday....followed by a severe rejection of the rejection on Friday. Got it? Good.

In addition to the veritable Everest of event risk this week, we are also at a fairly critical technical juncture as well. The break of the relevant trendlines and moving averages has been well-flagged, both here and elsewhere. But the recent uptick in the VIX has also taken it to interesting levels. Way back in the day, when Lehman Brothers still roamed the earth, the 30 level on the VIX usually signalled the wash-out point for bear moves in the stock market. As you can see, both before and after Lehman, equities generally turned when the VIX got to 30+, thus sending the VIX itself back down.
So in a sense, this week will provide an interesitng laboratory for us to determine if the market truly is more "normal", or whether the darkest fears of the most ursine bears will be realized. If Macro Man were a sell-side analyst this morning, he'd probably write something like "risky assets are either a great buy or a great sale at these levels...by Friday we'll know which one." In practice, it is unsurprising that implied vol across assets is getting pumped up.

Indeed, the week has already witnessed its first "volatility event." Unluggy Mrs. Watanabe, perennially poor punter of foreign exchange, experienced a Manute-sized drawdown in her account today. ZAR/JPY, a cross that offers granite-like liquidity at the best of times, was evidently the subject of a horrendously-executed margin call stop-loss run, which sent the cross down 10% from Friday's highs.
Naturally, it has since recouped virtually all the losses, giving a Manute-sized headache to Mrs. Watanabe and anyone else unfortunate enough to leave a round-the-clock stop loss order in the ZAR.

Anyhow, it's game on, and this week will set the stage for the end of the year. Macro Man is preparing to take his shots; he can only hope that he doesn't encounter Manute barring his way to the basket.

Treat....or Trick?

noreply@blogger.com (Macro Man) — Fri, 30 Oct 2009 09:47:00 +0000

This equity price action is becoming almost Biblical: "and on the fifth day, the market rose again...." Macro Man was somewhat bemused by the enthusiastic reception to yesterday's GDP number, by the economics profession at least as much as the marketplace.

After a four-day slide, that an above-consensus real GDP print encouraged a bounce was hardly shocking, particularly in light of the history of the last seven months. Yet the reaction from sell-side economists: "A very strong report! We're upgrading our forecasts!" bordered on the nonsensiscal.

For one thing, the margin of the consensus "beat" was razor-thin: 0.3% anuualized is less than 0.1% q/q. That this is the advance number that will be revised twice in the next month or two provides even less reason to go overboard with the enthusiasm.

More viscerally, however, to Macro Man's mind the report was actually worse than expected. Years of poring through Japanese national accounts data have taught him that in deflationary/bubble-bursting/highly distressed economies, nominal GDP is what matters. And on that score, the resultant figure- + 4.3% q/q, SAAR - undershot the 4.6% consensus by the same margin that the real figure beat it by.

Moreover, as the chart above illustrates, the quarterly nimonal growth was well below "trend", even as the real figure exceeded trend. Colour Macro Man unimpressed. Of course, there were some positive aspects to the report: residential construction rose for the first time since 4Q05. Of course, whether that can continue with plenty of untapped housing supply from foreclosure sales remains to be seen. Similarly, the surge in auto sales and the decline in the savings rate last quarter suggests that it will be difficult to maintain a 2.36% contribution to growth from household spending.
Meanwhile, the latest interesting twist out of Korea occured last night. Industrial production surged 5.4% in September, taking the y/y growth rate to 11% and the underlying production index to an all time high. This, combined with the smart bounce in the US, surely gave a tasty boost to the Kospi, right?

Nuh-unh. After a half-hearted gap higher on the open, the index sagged badly into the close, falling to its lowest level since August 20th. The divergence vetween the Kospi and IP is curious, not least because the Kospi peaked more than a month ago, leading other markets by several weeks.
At the risk of beating a dead horse, Macro Man finds it very interesting and very troublesome that a cyclical market like Korea with apparently rock-solid macro fundamentals is trading so poorly. By way of comparison, the SPX was at 1007 the last time that the Kospi closed as low as it did today.

It's the season for tricks and treats (hint: here comes the obligatory Halloween tie-in); somewhat worryingly, it's becoming a tad tricky to tell the difference between them. The evidence is increasingly mounting that the naked liquidity trade is coming to an end, and that markets will soon have to float or sink on their own merits. Judge for yourselves what that implies for the goodies that have stuffed many high-beta portfolios over the past couple of quarters.

Crucial

noreply@blogger.com (Macro Man) — Thu, 29 Oct 2009 08:56:00 +0000

"Life all comes down to a few moments. This is one of them."
-Bud Fox, Wall Street

Looking back on his sixteen year career in finance, it's been Macro Man's experience that each year is often defined by a handful of critical days or events. While Bud Fox had the benefit of knowing how important his visit to Gordon Gekko's office would be, it's often not quite as obvious in real time how important an event will be.

When Ralph Cioffi's Bear Stearns hedge funds blwe up in July 2007, for example, it was viewed as in interesting development that might result in an orthodox phase of risk aversion; little did we know that it would usher in a global financial meltdown the likes of which none of us had ever seen. Similarly, when Macro Man took to the slopes on Friday, February 13 this year, he had no clue that it would become the defining day of the year for him (which happened when he blew out his knee in waist-deep powder.)

Today, on the other hand, has all the hallmarks of a potentially defining day for the rest of the year. Yesterday saw the SPX close below its uptrend line from the March lows; while prior trendlines have been violated more often than traffic laws by your average London cyclist, this time may be different. Even as the index was making new highs, the RSI was making lower highs- a classic momentum divergence that signals trend exhaustion and possible reversal.
Moreover, the market has gone down four days in a row. According to Macro Man's mate "Nick the Greek" at Citi NY, this has happened three previous times since the March 9 low: the average return on day 5 has been 1.66%. Adding spice to the chili is the release of Q3 advance GDP; with a forecast range of 2% to 4.8% around a median of 3.2%, the potential for someone to be surprised is rather large. Anyhow, the point is that if (and aat this juncture, it remains a very big if) equities put in another poor day's performance today, it may be a signal that something has changed.

Obviously, next week will also prove critical, with ISM, payrolls, and the Fed. There appears to be something of a divergence in pricing across markets. On the face of it, the dollar and equities look to be pricing in the removal of the "extended period" language, which acccording to the recent Guha article would imply that the Fed could (rather than will) raise rates within six months. But then looking at the strip, where December 2010 eurodollars are more or less at their highs of the entire cucle, it seems likely that such an outcome is not fully priced into fixed income.
As usual, reality is more complicated than it seems at first appearances. The dollar has evidently been buoyed not only by all the mumbling about the Fed, but also by the more prosaic (and powerful) fact that US corporates have been aggressively buying dollars. That positive earnings outcomes have been skewed towards those firms with large international sales is probably not a coincidence; still, the apparent vehemence off the flow is notable.

One other little development has caught Macro Man's eye. It may be nothing but an attractive p.a. investing opportunity, but it may be more, and to Macro Man's mind raises question about LIBORs. NS&I, which administers the UK version of savings bonds, recently icnreased their one year fixed rate interest on offer to 3.95%. To put this rate into contrast, one year Gilts offer a yield of 0.46%, one year swap yields are 0.93%, and the entire LIBOR complex is well, well below that level.
Now, if you are a depositor with excess cash who is willing to forego liquidity for a year, why would you ever leave the money on deposit with the bank, where savings rates are miniscule? Surely these rates are going to vulture deposits away from the banking sector? And if the banking sector loses desposits, shouldn't LIBOR move higher?

There is a hell of a lot of complacency in global front-end trades which, to Macro Man's eye, look close to fully-priced. The risk is surely skewed towards LIBOR-OIS widening, rather than narrowing? And if that happens, it could well be a crucial development for financial markets.

Wobbles

noreply@blogger.com (Macro Man) — Wed, 28 Oct 2009 09:37:00 +0000

It's all looking more than a little wobbly this morning. After yesterday's solid 10 year auction helped stem the bloodflow from the execrable consumer confidence figure, equities managed to put in a fairly "blah" close, which suddenly seems like the new "high volume percent and a half melt-up."

The canary in the coal mine for the current market came from, of all places Australia. Quarterly CPI was released a bit highre than expected; given the recent AUD love-fest and the swirling focus on RBA tightening, this surely led to a nice rally in the Oz, right? Not so fast, my friend. Of all the flamingos out there, AUD is surely among the biggest, given that there is apparently nothing wrong with it. Or maybe there is. The Aussie banking sector, which has largely flown under the radar during the entire crisis, apparently has a few skeletons (or at least turds) in its closet, as NAB's earnings report was an absolute shocker. The AUD has been spanked as a result, which surely must tell us something.

Meanwhile, European banks have continued their descent down the liuft shift this morning, with Irish banks grabbing this morning's "limelight." It's been a while since financial stability has been any sort of focus, but it is pretty striking that every mornin this week, Macro Man has beens serendaed with comments like "ING down 20%" or "Bank of Ireland down 15%." The European banking index doesn't look any better than the BKX; given the relative lack of pain taken by European banks, one could easily argue that the downside for the SX7E is greater.
And w(h)ither the euro? It's hard for Macro Man to figure out whether this just a flamingo-y position squeeze, the by now-usual month-end jitters, a reaction to a possible change of Fed language, or a Leftback-style "Big One."

What's interesting to note is that amongst the cosmic background radiation of the DGDF trade has been signs of a vulnerability to a dollar rally. If we overlay EUR/USD with the skew in 1 month 25d risk reversals, we see that for the first half of the year the correlation is quite high. Over the last few months, though, even as the dollar was going down the drain, the riskies came off ; they've actually been bid for euro puts for most of this month. Again, whether that's a canary in the coal mine or prudent hedging remains to be seen, but it is certainly curious.

Overall, Macro Man's expectation of higher volatility trading conditions is looking prescient (or at least more accurate than this week's directional calls). The last several months have seen month-end wobbles, which have swiftly righted themselves once the calendar page flips. With the Fed, NFP, and G20 looming, the jury is still out on the current wobbles. Will markets prove to be Weebles, or Michael Spinks?

Not The Best Start

noreply@blogger.com (Macro Man) — Tue, 27 Oct 2009 09:15:00 +0000

Macro Man's not had the best start to his day. Macro Boy the Elder, giddy that half term school holidays have arrived already, woke up at half past four this morning and decided that he wanted to watch television. He was swiftly dispatched back to bed, but the harmony of the night's sleep was shattered.

Then, when it came to catch the train this morning, the great British railway system performed its predictable collapse in standards whenever the clocks change by offering a half-length train. There's almost nothing worse than being crammed into a cattle-shed train at 6.30 am with some guy's butt three inches from your face. One of the few things that qualifies is being crammed into a cattle-shed train at 6.30 am with some guy's butt three inches from your face and spilling scalding hot coffee all over yourself.

Another, if you were limit short dollars, was yesterday's price action in foreign exchange. While USD/Asia has had a bid tone for a week and a half, as recently as yesterday morning EUR/USD was at its highs. Cue a correction, a break of a highly-visible uptrend line, and a lot of head-scratching.
The dollar's gotten further support from a Steve Beckner article suggesting that the Fed will say that they give a crap about the value of the buck. At the same time, things are starting to look a little wobbly. It's interesting to note that the star performers of the summer, turds such as FNM and FRE, are down nearly 50% from their recent highs. Meanwhile, European banks have been clubbed - ING is down 25% in the last 2 days- even as the macro data offers little comfort that it's all sunshine and sweetness in the pipeline. Today's M3 growth data in the Eurozone showed continued straight-line deceleration...not exactly good news.
It's not just European banks that are wobbly- the BKX also looks dreadful. Perhaps it's just a wobble...but maybe not. While it's certainly not out of character for markets to test the resolve of weak hands, there has clearly been a bit of a shift in the tone of the reflation trade over the past week or two: it's gone from fairly relaxing to rather bumpy.
In markets, as in sports, it's not about how you start but how you finish. Macro Man's month appears to be ending as his day today started, so he's gotta put his nose to the grindstone to manage risk and turn this sucker around.

noreply@blogger.com (Macro Man) — Mon, 26 Oct 2009 09:38:00 +0000

This weekend in the Macro Man household was all about "savings". West Ham unexpectedly saved a draw against Arsenal after being down 0-2 at the half, which left them....err....still second bottom in the league. Then the once-mighty Steelers defense saved the team not once, but twice against The Clash by returning fourth-quarter turnovers for touchdowns (sandwiching a kickoff return TD by the Vikes.)

Then, of course, there was the daylight savings-related turning back of the clocks here in Europe, which gave us an extra hour yesterday but doesn't actually save daylight at all- quite the contrary, as we now enter the long, dark winter where it's pitch black at 5 pm. Ugh.

Anyhow, all of this focus on savings led Macro Man to consider the question of savings from an economic perspective. Ever since the financial crisis went nuclear last year, Macro Man has held the view that the US personal savings rate would approach if not breach 10%. It is for this reason that he was largely disdainful of the green shoots phenomenon for much of the summer.

Of course, in real time, that view proved to be wrong. While Macro Man's relatively pessimistic views on the labour market have proven to be accurate, Cash for Clunkers, among other things, encouraged the consumer to go back to the well, sending the savings rate from 6% to 3%.

Macro Man has a couple of thoughts on the phenomenon. First, it is pretty undesirable from a long-run perspective; US households need to spend less, from both an internal (re-balancing the composition of GDP growth) and external (re-balancing global current accounts) perspective. A swift return to the consumer's recent spendthrift ways is not encouraging.

However, if one posits that cash-for-clunkers merely brought forward future spending (which seems a reasonable proposition, given ongoing frailties in the labour market), then the bullish expectation of a V-shaped recovery, with the right side of the V just as steep and just as long as the left side, may well be misplaced. Those sorts of recoveries are engineered once pent-up demand is unleashed. From Macro Man's perch, a halving of the savings rate this early in the cycle suggests that this is unlikely to happen this time around.

Another country plagued by a savings problem is, funny enough, Japan. Over the past two decades, the household savings rate has plunged from the high teens to the low single digits. Ironically, this is exactly the policy prescription that a parade of US Treasury officials have recommended to Japan since the mid-90's (and are currently recommending to the rest of Asia.) Unfortunately, the decline in savings has come not via higher spending, but via reduced incomes.

And it's not only households that have seen their incomes reduced; the central government has been forced to drastically reduce its estimated tax take. This has led to something of a brewing crisis; the new DPJ government seems to be flirting with markedly increasing net JGB issuance, even as the Postal Savings dials down its purchases to fund withdrawals and benefit payments.

As a result, JGBs have been on something of a slippery slope recently, trending down nicely over the course of the month. At the same time, the yen has recently quit being an "anti-dollar", and seems to have latterly joined the dollar and sterling in the global currency doghouse.
Whether the downtrend in JGBs and the yen persists remains to be seen, of course. Japan certainly compares favourably to the US and UK in terms of its stock of savings. However, the government is, if anything, more profligate and in more trouble than the Anglo-Saxons; given that the yen has traded as something of an uber-currency over the last few months, one might reasonably posit that moving from a penthouse currency to an outhouse one might provoke quite a sharp move. Naturally, Mrs. Watanabe is now quite long of yen in her currency speculations; just doing her bit, no doubt, to reduce the level of savings in Japan.....

The Treadmill

noreply@blogger.com (Macro Man) — Fri, 23 Oct 2009 08:49:00 +0000

When market punters chat to each other, which they often do, the conversation almost inevitably opens with some variant of "So how you getting on?"

The typical response bears a striking resemblance to that of high-level amateur athletes. When you ask somebody, for example, how well they ski, it seems that the best skiers almost always reply with "oh, I'm OK." In Macro Man's experience, people who reply "yeah, I'm pretty good" generally are not. (By way of disclaimer, Macro Man was a "yeah I'm OK" guy before he came a-cropper.)

In any event, Macro Man's standard answer to market punters these days likens his mentality to that of a runner on a treadmill: he feels like he has to run as fast as he can just to stay still. Ever since the SPX market bottom on March 9, the year has been something of a grind. Given his largely incorrect big-picture view, Macro Man adopted a sort of macro RV strategy after he returned from his knee surgery.

It has done OK, but as we approach year end and assets appear to be trading largely off of the available liquidity, his strategy has ground to a halt. So at the beginning of this month, he decided to pump up the vol a little bit and become a bit more directional. The problem with that, despite the SPX and EUR/USD trading at their highs of the year, is that it's been pretty damned noisy. The last 72 hours in US equities are a prime example of how easy it is to get sucked into doing something stupid:

The noise surrounding Fed policy and possible exit strategies doesn't make it any easier. For if and when the Fed does withdraw accommodation, it seems likely that today's stellar performers will be tomorrow's home-run shorts. As such, today's trial balloon in the FT on the Fed's semiotics has sparked substantial interest (though curiously, only fixed income markets seem to have reacted.)

While this will certainly be a key theme for 2010, it looks to be a premature consideratoin this side of new year. Macro Man likes to look at a simple Taylor rule proxy, which is the y/y change in nominal GDP. As the chart below illustrates, it has pegged levels and changes in the Fed funds rate pretty well over the past forty years. What's cool is that the chart highlights two periods of overly-lax Fed policy error: the 1970's, which produced high levels of inflation (and was followed by the Volcker Fed bringing down the hammer in the early 80's) and Easy Al's free-money giveaway in the early part of the Noughties.

While y/y nominal GDP is likely to turn up when it is released next week, it seems unlikely to print levels that would be consisent with a need for higher rates until the middle of next year. Still, this game is not so much about predicting what will happen in 6-9 months as predicting what the market believes will happen. Obviously, there are exceptions to that rule, and the longer your time horizon, the more you can focus on your forecast. But in a world of ten-minute macro, market belief matters.
Ultimately, of course, you can't buck the data, as recent purchasers of sterling found to their detriment this morning. Q3 GDP shocked the consensus by printing -0.4% q/q, prolonging the recession, re-opening the case for QE and giving the queen's head a proper slap on the cheek.
Alas, Macro Man's bearish GBP options look set to expire worthless next week. Such is the joy of directional trading, where you have to get your direction and your timing right. Is it any wonder that Macro Man feels like these guys?

Oooooffff

noreply@blogger.com (Macro Man) — Thu, 22 Oct 2009 08:48:00 +0000

If you've ever been punched in the solar plexus or had the wind knocked out of you, then you probably know how risk assets feel right now. When Macro Man threw the steaks on the barbie last night, the SPX was pushing 1100 and oil was nearly $82/bbl. When he checked his screen 40 minutes later, he could almost literally hear the "ooooooooooooof!" being cried by Spoos.

Ex post, a number of reasons were given for the sell-off: Bove downgrading WFC, Obama announcing pay caps on TARP banks, a disappointing Wal-Mart call, etc. The real answer, however, is a bit more prosaic: a couple of huge ($5 billion) sell tickets went through in the last 40 minutes or so of trading, which naturally pushed the price lower. You can see the impact on the intraday volume chart below.Meanwhile, other sacred (risky) cows are being ushered to Dr. Market's abattoir. Over the past few weeks Macro Man has pointed out the apparent distribution trend in Korean equities. Despite this, the won had remained relatively resilient, in conjunction with the splendid performance of broader stock markets. Starting last Friday, however, there has been something of a fire-in-the-theater rush for the exits in KRW, INR, and other Asian currencies. Even USD/RMB forwards have seen some short-overing.

As long as the Fed remains accommodative (and yesterday's Beige Book suggests that it will), this sell-off in stuff like EMFX is probably little more than a bit o' flamingo hunting. (There has been some rumbling that recent FX price action is related to the Galleon closure, but the relatively small AUM of their non-equity books suggets that this is wide of the mark.)

One market clearly seeing pink flamingos being shot down is short sterling. Yesterday's BOE minutes suggested little appetite to expand QE, and even suggested that soem members are getting a trifle concerned about the Bank's relatively sanguine longer term inflation forecast.

Cue the predictable ralling in sterling (the currency) and kiboshing of sterling (the interest rate contract.) While Macro Man does have sympathy with the notion that Merve will wake up one day and Swerve hawkishly (and thus understands the recent carnage in the reds), the recent kiboshing of front Dec looks decidedly flamingo-y, and may have overshot.

As the chart below demonstrates, front Dec is now pricing 3m LIBOR nealr y10 bps higher than the current reading. The would put the spread over the BOE's interest on reserves at 16-17 bps. Compare that with, say, the US, where 3m LIBOR is currently just 3 bps over the 25 that the Fed pays on its reserves.
Ultimatelty, Macro Man suspects that liquidity will remain ample this side of new year, and that front Dec sterling looks like it's starting to offer some value.

Perhaps there is actually a little too much liquidity, at least in the US. news that John Meriwether is going for strike three literally beggars belief. Sadly, it's been Macro Man's experience that European investors don't have nearly as much money to piss away........

Roots

noreply@blogger.com (Macro Man) — Wed, 21 Oct 2009 07:57:00 +0000

Macro Man has previously observed that blog traffic can sometimes say a lot about the significance of market events or interest in a particular theme. If this is the case, then it appears that concern about the weakness of the dollar is very real, as yesterday's post generated a near-record level of traffic. This was largely due to the fact that a few high profile sites very kindly linked to Tuesday's post, but still....someone has to be interested enough in the subject to click through. For the first time in a couple of years, Macro Man finds the subject of external imbalances to be of paramount interest, and since Brad Setser moved on to bigger things, there is perhaps a dearth of commentary on the subject.
Regardless, the drumbeat of dollar weakness rolls on, as the buck is back close to its lows of the year against the euro. Exotic barriers around 1.50 have, by all acccounts, helped put a lid on spot for now, but one would have to believe that it's only a matter of time before the level breaks. Hell, even sterling has continued last week's bid tone; if the BOE minutes don't hint at an appetite for more QE in December, one might reasonably conclude that the Queen's head could enjoy another dies mirabilis.

Although equities had a bit of a setback yesterday, the pro-risk drumbeat marches on (despite the swirling winds of financial and economic protectionism.) While the Bank of Canada intimated yesterday that loonie strength would stay their hand on rates for another couple of quarters, another strong currency phobic CB, the RBNZ, changed its tune by suggesting that the strength of the kiwi would not preclude rate hikes.

And in the London morning, China leaked its September industrial production figure, due to be released tomorrow, at a better than expected 14.1%. You could almost literally hear the risk longs shouting "hip hip hooray!"
Regular readers will know that Macro Man has been (incorrectly) fairly sceptical of the green shoots phenomenon and has fought the equity rally (if not position-wise, at least intellectually) for much of the way up. One factor that he almost certainly underestimated, or missed altogether, is that of margins. As a top-down macro guy, he doesn't really gt his hands dirty with company- or sector-specific margin analysis; he has neither the data nor the expertise to do so.

But as a top-down macro guy with a penchant for crafting little indicators, he does have a proxy that he was watched for the last few years to give him a rough idea of what margins are like. Simply put, he looks at the y/y change in US CPI ( a proxy for corporate selling prices) against the y/y change in finished goods PPI ( a proxy for corporate costs.)

To be sure, the proxy isn't perfect, nor is it intended to be. But it ain't half bad as a rough-and-ready indicator, as you'll observe that prior "negative margin" readings have typically coincided with recessions/bear markets/ticking timebombs.
As you can observe, after plunging to record negative territory in H2 of last year (a period that coincided with near-record negative equity performance!), the margin proxy screamed higher earlier this year. Macro Man ignored this signal to his detriment. Today, the margin proxy is stabilizing at relatively high levels which, much as Macro Man may hate to admit it, could suggest upside profit surprises (such as those observed thus far for Q3) if maintained.

Rest assured that he will pay this little indicator a bit more attention in the future; it won't just be with currencies that Macro Man gets back to his roots.

The Myth of The Strong Dollar Policy

noreply@blogger.com (Macro Man) — Tue, 20 Oct 2009 07:54:00 +0000

Here are five great myths and/or lies of the modern financial system:

1) "The check is in the mail"

2) "I'll call you right back"

3) "We are long-term investors"

4) There is a secret cabal of gnome-like creatures that manipulate the gold price (up or down, depending on your druthers)

5) "The United States believes in a strong dollar"

When the strong dollar policy was formulated by Bob Rubin in 1995, it was sincere and served a purpose. After all, the Treasury market had experienced a horrible sell-off the previous year and the buck made all-time lows against the JPY and DEM in 1Q95, prompting the last bit of multilateral currency intervention in which the US was an enthusiastic participant.

And one could argue that the policy served a useful purpose throughout the 90's; by maintaining tight monetary conditions, it replaced some element of Fed rate tightening, while at the same time affording the US a useful (positive) terms of trade shock. It was only a decade ago that oil flirted with $10/bbl!

However, in the Noughties, a decade dominated by global imbalances, the bond conundrum, and a host of other resource misallocations, it's been quite clear for some time that the strong dollar policy is a farce worthy of Rabelais. It's a well-known fact that the strong dollar policy is a hollow one, and Macro Man can only conclude that in diplomatic circles, it must represent the epitome of poor taste for JCT, among others, to reiterate their support for what has become a "strong dollar" policy (emphasis on the quotes.)

'Tis a pity, really; the strong dollar policy once served a useful purpose, and it's not difficult to envisage it doing so again. By failing to withdraw its support of an overtly strong dollar when one was no longer desirable (quite the contrary), the US Treasury has done America and the rest of the world a disservice.

Of course, it's a tad rich for JCT to dance around someone else's linguistic parlour tricks; after all, he is the undisputed master of speaking in a literary code of his own devising (remember 'strong vigilance'?!?!). And even in the currency realm, the Europeans have their own form of linguistic semaphore; when Europe warns of "excessive volatility" in currncy rates, they are really moaning about the level of the euro.

For if it really were volatility that Europe cared about, then they should be chuffed to bits. As the chart below demonstrates, one month realized vol in EUR/USD has collapsed in recent months and is now, at 6.9%, at the low end of the post-Bretton Woods range.
Belatedly, of course, the Europeans seem to have noticed that the Chinese aren't exactly playing "good neighbours" when it comes to global currency policy. And so after years of American financial diplomats trudging to Beijing to wag their fingers at the unrecalcitrant Chinese, Messrs. Trichet and Juncker will be making a similar pilgrimmage over the next couple of months.

For some reason, Macro Man can't shake the Kim Jong-Il/ Hans Blix scene from Team America from his mind, though he suspects that feeding the European worthies to a shark tank would probably not escape notice.

The best that the Europeans can probably hope for, however, is if the Chinese response is something like this:

Meanwhile, Brazil has re-instituted a punitive tax on foreign capital, a week after Turkey was rumoured to be contemplating a similar arrangement. Taxes on capital, moaning on currencies, nothing on interest rates. You can almost literally see the wagons circling as each country looks out for #1.

It's entirely possible for this liquidity/positioning/DGDF rally in risky assets to continue through year end; in many ways, it's in everyone's best interest for this to happen. But Macro Man can't shake the feeling that we're all repeating the mistakes of the last cycle (in fast forward, no less!) and that when the reckoning comes, it won't be much fun.

Velocity

noreply@blogger.com (Macro Man) — Mon, 19 Oct 2009 08:11:00 +0000

The week has started with a bit of a bang, as the Barron's cover story arguing for a Fed rate hike sent equity longs and dollar shorts scurrying for cover. Well, for a couple of hours at least; after the initial flurry, both equities and non-dollar currencies saw solid demand and are, at the time of writing, solidly up on the day.

The Barron's article contrasts starkly with views expressed in the weekend press by Adam Posen, newest member of the BOE MPC (and, as it so happens, a former colleague of one Benjamin S. Bernanke) arguing if favour of more, not less, QE.

We are now entering treacherous waters for monetary authorities in highly-leveraged economies. Given the decade(s)-long dependence on the credit mechanism to spur economic growth, the financial crisis has brought about a precipitous decline in the velocity of money- i.e., how much economic activity is generated per unit of money supply. Bloomberg helpfully calculates a velocity indicator; as you can see, while recent fall has been steep, velocity never really recovered from the heady days of the 90's productivity boom (and..err....internet bubble.)
If the average or median citizen feels like they never really participated in the Noughties recovery, this is perhaps an indication of why. Q3 data, to be released towards the end of next week, will probably show a very modest uptick in velocity (presuming a small positive growth reading for nominal GDP in a quarter when M2 was broadly stable.)

Given the damage inflicted on Main Street by this recession, the Fed will almost certainly want to see what looks to be a sustained uptick in the "economic" velocity of money before meaningfully tightening the taps; after all, we know that Big Ben is a student of the Depression and of the policy mistakes that occured in the 30's.

So what's the problem? Well, the challenge for the Federales is that there are some areas where velocity has picked up- namely, financial markets. Macro Man constructed a rough and ready "financial velocity" index, which is the ratio of an index of financial markets (the SPX, 10 year Treasury futures, EUR/USD, gold, and oil, all equally weighted) to M2. As you can see, after a calamitous decline in the teeth of the crisis, over the last couple of quarters financial velocity has picked up nicely.
So herein lies the problem; the vast bulk of the veritable Everest of Fed liquidity provisions seems to have found its way onto Wall Street, not Main Street. Not that you didn't know this, of course; however, it seems close to inevitable that there will be a significant backlash against, ahem, "well-connected" banks that have benefited disproportionately from the Fed's largesse.

Now, the Fed might say that "that's a problem for the Administration, not for us." OK, fine. But the question still remains; does the Fed shape policy to goose economic velocity higher (in which case lower for longer will be the outcome), or does it at long last address asset prices ('twould be troubling to see financial velocity start exceeding the 2002-2006 trend.)

There really isn't an obvious answer. It seems clear, however, that the government (and not just in the US, mind you) will wish to align the fortunes of Wall Street and Main Street more closely. Indeed, during the first six years or so of the Noughties, economic and financial velocity were relatively well-correlated...
...only to diverge sharply since 2007.
Re-aligning the two would appear to be a task well outside the scope of monetary policy; small wonder, then, that pockets of policymakers the world over are expressing considerable zeal for financial regulation.

And where does that leave the Fed? Fervently praying that economic velocity picks up so that their job becomes a bit easier!

Flamingo, Fright, or Friday?

noreply@blogger.com (Macro Man) — Fri, 16 Oct 2009 08:09:00 +0000

Although Macro Man didn't ouch on it yesterday, his "no frills" earnings model for Goldman Sachs once again proved its worth, as the "consensus plus a buck" methodology proved to bve deadly accurate. Why pay analysts a couple million bucks a year when the no frills model does so well?

In any event, given that someone had whispered $6/share yesterday, and that Citi's reportwere less than stellar, stocks generally traded on the back foot. Nothing that IBM and Google couldn't rememdy afte the close, of course, and SPX futures have made a new high for the year in this morning's trade.

The real story, however, is in oil, which has finally broken out of four or five months of consolidation. Yesterday's bullish inventory data was met with a bullish response, which probably means that the trend is...err....bullish. $85 forecasts are now a dime a dozen; while another 10%-15% on the oil price may seem a bit too obvious, the set-up is not unlike the SPX price action in July.
Perhaps spurred by the oil price, some of the widely-populated front-end rate contracts have come under a bit of pressure, as indeed have some of the oil-importing Asian currencies. Indeed, despite the spike in crude, the dollar has felt decidedly squeezy for the last 24 hours; remarkable comments like Trichet's "the euro wasn't intended as a reserve currency" just added to the "fun".

So Macro Man is left wondering whether these jitters are merely the occupational hazard of the occasional market fright, a to-be-expected round of Friday profit taking after remunerative week, or a warnings sign that flamingo hunting season has started.

In truth, there's probably an element of all three. Macro Man has already pointed out the emergence of a distrubution phase in the Kospi, which is certainly consistent with profit-taking. For markets to climb a wall of worry (or tumble down the elevator shaft of complacency) necessarily entails the odd bout of nerves.

But without a doubt, there is the odd flamingo or two that have been passed. Exhibit A is GBP/JPY, which reversed sharply after a seemingly inexorable decline over the past couple of months. The timing seems odd from a fundamental perspective, given that this week saw one of the few CPI prints of the year that didn't surprise to the upside.
Ah, but when it's flamingo season, positioning is the only thing that matters! And positioning in GBP/JPY has been...ahem...extreme. The CTA model community, as proxied by IMM positioning, has its largest short GBP/JPY position ever. (The chart below only goes back to 2004, but would look the same if taken back to 1992.)
Anecdotal surveys on real money and discretionary hedge fund positioning appear to confirm that this was a big 'un.

The risk, of course, is that if the damage exacted by this cross proves sufficiently large, it could start to encourage profit-taking in other widely-held positions...the classic passing of the pink flamingo.

At this juncture, however, it might be a little premature that that will necessarily ensue. But Macro Man planss to keep and eye on whether this development is just a Friday jitter, an orthodox market right, or a prelude to flamingo season.

How Big Is The Output Gap?

noreply@blogger.com (Macro Man) — Thu, 15 Oct 2009 08:11:00 +0000

Macro Man has thus far avoided the great "deflation versus inflation" debate, at least publicly, for a couple of reasons. The first is that he doesn't think the outcome will be as black and white as many of the debate's participants; he suspects the underlying dynamic is heavily dependent on the velocity of money, and so he prefers to focus his analytical energies in that direction. Moreover, the tone of the debate has taken on a quasi-religious tone, which is rarely conducive to the sort of open-minded give-and-take that yields substantive results.

However, it's probably worth touching on some small aspect of the debate, as behind the scenes it seems as if the same is happeneing at the Fed. Don Kohn's recent speech highlighted the large size of the output gap, a view largely echoed in last night's FOMC minutes. Yet at a recent St. Louis Fed conference, Bank president James Bullard offered a somewhat contrary view-namely that the collapse of the bubble has eradicated some of the productive capacity of the economy, thus rendering the output gap smaller than commonly believed.

This is an interesting and important issue, not least because the Greenspan Fed's belief in a large output gap was a major factor behind the policy mistake of leaving rates too low for too long in 2003-04.

Macro Man must confess that he has some sympathy for Bullard's view. A quick look at US manufacturing capacity, for example, shows that it has actually shrunk over the past year. Not as much as demand for that capacity has, of course, but still....it's quite a telling sign. While there is no accurate official measure of the total capital stock, Macro Man has to believe that it has been depleted as well.
Of course, a counter-argument to the notion of a smaller "national" output gap is the fact that consumer-driven Anglo-Saxon economies have essentially outsourced their manufacturing capacity, so you need to consider the notion of a "global" output gap. Well, perhaps....but even then there is no assurance that there is a limitless supply of foreign-made manufactured goods. The UK and US in particular- deficit countries with weak currncies- have seen foreign makers of certain goods drastically reduce the supply of their wares.

One small anecdote- Macro Man is looking to replace Mrs. Macro's Volvo station wagon. He's got his eye on a few diffferent Audi models (Q5, A4 estate.) There is basically no inventory in the UK, and no intention on the part of dealers to replenish inventory, so all cars have to be made to order . If you're lucky, you'll get a new one in March or April....at the earliest. Meanwhile, the prices of used cars have unsurpisingly ticked higher as well. So much for the yawning output gap...

Yesterday's post examined certain relationships in international trade. Macro Man suspects that most observers would concede that China has become the United States' foreign manufacturer of choice. Given the combination of a) continued overcapcity in China, b) the ongoing relative paucity of demand in the US, and c) the steadiness of the USD/RMB exchange rate, it seems reasonable to accept tthat US import prices from China should be low and falling, right?

While it's certainly the case that import prices from China are still down year-on-year, intriguingly, the quarterly change in import prices has returned to zero. In other words, there is no marginal deflationary trend in US import prices from China. If (or rather, when) domestic inflation in China starts to rise, courtesy of PBOC's helicopter money-drop, it seems reasonable to posit that US import prices from China will begin to rise.

Whither that global output gap?
So it was with great interest last night that Macro Man read of the divergence of views on the FOMC. One member wanted to reduce QE by not buying the full slate of MBS. AT least two voters, on the other hand, wanted to increase QE- despite the bounce in the data and the uber-rally in risk assets.

Now that the world is no longer coming to an end at the speed of light, it seems as if the Bernanke Fed is reverting to its original communications philosophy (i.e., members will be allowed to speak their own minds rather than toe the party line.) Given the disparity of views on the committee and amongst non-voting regional presidents, this seems likely to enegender a fair amount of volatility.

That the balance of opinion last month leaned towards more, rather than less, QE, could well introduce more of a risk premium into US markets. The curve has stepeend quite a bit in recent days as flatteners have been taken off.
At the same time, the dollar is once again on the back foot (even falling against sterling this morning!), as it should be given the quiescent attitude towards expanding QE. Ultimately, of course, the free lunch of dollar weakness may prove to have a bill, after all. That the oil price is threatening to break out of its recent range is perhaps an ominous signal; if inventories show a decent draw this afternoon, it could be off to the races.

And once again, the market will be left to wonder how big the suposedly yawning (energy) output gap really is, at least in the short run....

There Is No Divine Right To A Trade Surplus

noreply@blogger.com (Macro Man) — Wed, 14 Oct 2009 07:49:00 +0000

Another day, another dollar (going down forever.) The reflation trade is on, so on, baby, kick-started by Don Kohn's suggestion last night that the output gap is wider than the Grand Canyon and another wave of better than expected earnings, led by Intel after last night's close. JP Morgan announces at noon London today, kicking off a busy week of ~~kleptocrats'~~ banks' earnings.

But while equities are performing strongly, the real story of the day thus far has once again been the dollar. Not only has EUR/USD made a new high for the year above 1.49, but now even oil has broken out, suggesting that a sinking dollar lifts all boats.

While the dollar is traditionally weak in Q4 as FX reserve managers top up their non-US$ holdings (a trend that should be in full effect this year as Voldy and co. scoop up zillions in fresh reserves via intervention), it's hard to shake the feeling that the Obama administration is secretly delighted with the demise of the buck. To date, there have been no meaningful adverse effects of a dollar decline- Treasury auctions are still going swimmingly, and oil prices have been in a range for the past several months.

Sure, they've had to field the odd angry phone call from the Europeans, but that's pretty small potatoes to date. Still...it's not hard to see a scenario where the Eurogroup (and potentially the ECB) start hammering more forcefully on the Americans about dollar weakness and the Chinese about euro strength.

Yet while Macro Man has considerable sympathy for the view that China needs to quit taking the piss when it comes to its and others' currencies, he finds it less easy to swallow the Europeans' viewpoint vis-a-vis the dollar. A few charts will explain why.

The first chart below shows China's trade data, the September edition of which was released overnight. Gratifyingly for the green shoots brigade, imports were substantially stronger than expected, propelling a modestly lower trade surplus. Observe, however, how the proud owner of the world's largest trade surplus managed to safeguard its monthly positive trade reading throughout the entire financial crisis- helped, no doubt, by the decision to arrest a strengthening of the RMB versus the USD last July.

Now, it's certainly the case that China has been an active buyer of euros in the open market, and that that activity, when combined with their persistently large USD/RMB intervention, has exerted an upward pressure on EUR/RMB. So Europe has a beef, right? Well, maybe, but certainly one no larger than that of the Yanks. The chart below shows the difference between China's trade surplus with the US and its trade surplus with Europe. A positive reading shows that the surplus with the US is larger. As you can see, from 2H 07 - 1H 09, the two were roughly the same size. Over the past few months, however, China's surplus with the US has widened considerably relative to its surplus with Europe....and that's with EUR/USD trending higher.

Indeed, looking at Europe's trade figures, it's hard to see why they're a-bitchin'. Over the past several months, the extra-EMU balance has surged into surplus. Observe also how cyclical Europe's trade balance is, evolving from surplus to deficit and back again as the economic cycle turns. For a developed, mature economy like Europe's, this is almost certainly "fit and proper."

Compare the above chart with the equivalent one from the US; you can certainly see the impact of the financial crisis on the deficit, but also observe that that balance has remained in deficit consistently over the past seventeen years. Don't forget to check the scale, either; America's last, "small" trade deficit is basically three times the size as the worst one on the Eurozone chart. Remind me again why Europe is bitching?
When a demand-heavy country like the US experiences a negative shock, it's trade partners are supposed to see a retrenchment in their external balances. Canada, for example, has recently been registering record trade deficits (well, in fairness, any trade deficit in the Great White North is close to a record.) And while the BOC and FinMin have observed that the strength of the loonie is crimping the economy's style, to Macro Man's ear their observations have been considerably less strident than those emanating from Europe.
There's another interesting distinction to be drawn, namely between Switzerland and Japan. Both have traditionally enjoyed large trade and current account surpluses. Over the past seven months, the Swiss have obviously taken concrete steps to ~~weaken~~ "stabilize" the franc, thereby safe-guarding its trade surplus near all-time highs.
Compare that with the relatively newfound laissez-faire attitude of the Japanese towards the yen, which helped engender the first trade deficit in nearly thirty years. While the trade account has modestly tilted back into surplus, it's nowhere near as good relative to history as Switzerland's.
So what lessons are we to draw from all this? Looking at the assembled charts above, it seems pretty clear that (quelle surprise!) further rebalancing is required in the US. A weaker dollar would appear to be part of that equation; certainly the anecdotal evidence here in the UK (another persistent deficit country with a toilet paper currency) is that sterling weakness has curtailed the amount of foreign-made goods available for purchase.

Unfortunately, the (admittedly unscientific) contrast between Japan and Switzerland sends the message that protecting your patch is the right thing to do, while letting the global rebalancing chips fall where they may is an act of supreme folly. It's a message that China and Europe appear to have learned all too well.

Looming protectionism has been a flashing dot on Macro Man's radar for sometime; the apotheosis of the DGDF trend is likely to bring it into sharper focus. With the global recovery still on shaky footing, it seems likely that dollar weakness is going to force everyone (including the Americans) to try and protect their patch, whether they "should" be running a positive trade balance or not.

Unfortunately, there is no divine right to a trade surplus. Seventeenth and eighteenth century European monarchs once thought that they, too, had a divine right- in their case to rule as they saw fit. That worked fine.....until it didn't. (Just ask Charles I or Louis XVI!!)

One can only hope that the denouement to the current "divine right" thinking is a bit less bloody....

Withdrawal Symptoms

noreply@blogger.com (Macro Man) — Tue, 13 Oct 2009 08:24:00 +0000

The problem with heroin, of either the literal or monetary type, is that once you're hooked it's a very tricky proposition to wean yourself of the addiction. Gordon Brown certainly seems to be having trouble even contemplating kicking the habit; his public calls cheering QE yesterday appeared to stand on the toes of Merve the Swerve and co.

The next few months will present an interesting test case as some of the healthier liquidity addicts start kicking the habit. Exhibit A is Australia. The country presents an interesting dichotomy; as a producer of precious and industrial commodities, it has been highly geared to the global liquidity cycle, and particularly that in China. At the same time, domestic demand has remained robust, at least partially fueled by relatively heavy debt burdens (which have obviously benefitted from ultra-low RBA rates.)

So while Australia's export sector is more about developments in Chinese monetary policy than what the RBA does, households and the service sector are more clearly vulnerable to a tightening of policy. So it was with great interest that Macro Man saw that the NAB business confidence survey dipped from 18 to 14 last night. Admittedly, it's come from a very robust peak, and some normalization would be conssitent with still solid growth. But perhaps it isn't a coincidence that business confidence fell as soon as the RBA tightened; it will be interesting to track the evolution of this relationship moving forwards, particularly if and as the RBA starts going in clips of 50.South Korea is another country where policy is widely expected to tighten; with 3m month KORIBOR at 2.78%, 2 year onshore swap yields are currently 4.02%, up some 75 bps over the last six months. Over the same time period, the KRW has been the second strongest Asian currency against the dollar, rising 13.75% (trailing only the Indonesian rupiah.)

Macro Man observed the other week that the Kospi had started lagging the performance of the KRW, and indeed the SPX. While the index is well off its recent lows, its broad underperformance has remained intact. Drilling down beneath the surface, it certainly looks like Korean stocks are under distribution (i.e., someone is selling.)

One thing that Macro Man has observed recently is that the Kospi tends to open on its highs and trade lower during the day...even on positive days. Perhaps unsurprisingly, trends in this phenomenon (defined as the 10 day moving average of the difference between the daily closing price and the open) have tracked index price action pretty well over the last few months.
Interestingly, the magnitude of the recent distribution phase appears to exceed that of the orgiastic accumulation at the height of the summer rally. Now, perhaps this simply represents a nice profit-take on the part of global equity managers, who are re-deployiong the funds in more lucrative markets. On the other hand, maybe Korea is a canary in the coal fine in terms of liquidity withdrawal and a sign that even apparently robust and balanced Asian economies are a bit more hooked on monetary heroin than some bullish commentators would like to admit.

Macro Man intends to keep a close eye on these two markets; the real-time laboratories in Australia and Korea may provide a useful guie to what we can expect when the seriously addicted patients start entering rehab.

20 Questions

noreply@blogger.com (Macro Man) — Mon, 12 Oct 2009 08:31:00 +0000

It's a bank holiday in Japan, the US, and Canada today, so markets are feeling a bit listless- though not quite as much as your author. Given that we're well into Q4 now and Macro Man sees plenty of head-scratchers, what better time to play another game of 20 questions?

1) How real is the risk of a year-end melt-up in equities as pension and stock fund managers just throw money at the market out of a desire to show that they are overweight at year end?

2) How concerned should fundamental bulls be at the underperformance of Asian, supposed growth engine of the world, over the last month? (That's equities, not currencies or growth data.)

3) Will banks throw a bone to public opinion and magically conjure some turd-related losses by year end, or will they just brazenly print big profits, stick their fingers in their ears, and chat "nicky-nicky-nah-nah" at taxpayers?

4) A Tory majority or a hung parliament?

5) Actually, does David Cameron even qualify as a Tory (other than privileged upbringing, etc.)?

6) If Gordon Brown is going to sell the family jewels (again!) to ease the budget deficit, shouldn't sterling go up (given that h usually sells to foreigners)?

7) Is recent Fed rhetoric trying to prepare markets for a policy tightening of some description, or does it merely represent a return to the "anyone can say what they want" policy of the early Bernanke Fed?

8) The RBA was first. The Norgesbank will almost certainly be second. Of G10 central banks, who will be third?

9) Will the BOE augment its QE program by cutting the interest on bank reserves next month?

10) What's happened to the Steelers' defense? They can't stop anybody in the 4th quarter this year.

11) Which trades first on front-contract oil: $60 or $85?

12) Which trades first on gold bullion: $900 or $1200?

13) Is the deterioration in recent G2 bond auction results (last week's long bond auction in the US, today's failed German bill auction) telling us something?

14) Can you believe that GM is running an ad campaign based on build quality? No wonder they've gone bust.

15) Angels, Dodgers, Phillies, or Yankees?

16) When will USD/RMB go below 6.80?

17) The current fixed-income sell-off: pause that refreshes or prelude to carry-trade carnage?

18) Has anyone else observed a deterioration in the performance of cross-asset RV trades?

19) When will Mrs. Watanabe give up punting online FX? Her performance has been awwwfulllll!

20) Didja put a cheeky fiver on Obama winning the "Nobel Prize" for economics?

A Bit Spicier

noreply@blogger.com (Macro Man) — Fri, 09 Oct 2009 08:48:00 +0000

It's a busy day today and Macro Man is pressed for time (an early morning visit to the physiotherapist put him behind schedule), so today's post will be necessarily brief. Suffice to say things have gotten a bit spicier in the last 24 hours; while it need not derail the risk asset love-in, that doesn't mean that the fenders won't get scraped along the way.

First, an apology is in order: JCT was admirably restrained when it came to the euro yesterday, passing up the chance to have a good old moan. (A less charitable commentator might suggest that he folded like a deck chair or choked like a chicken, but Macro Man thinks that would be churlish.) Of course, JCT couldn't pass up a chance to pat himself on the back for maintaining anchored price expectations, which he did with well-practiced aplomb.

Still, his lack of complaint set the stage for a nice pop in EUR/USD, which duly followed after a bit of short-term profit-taking. Still, there are some cracks emerging in the warm salt-water bath of uber-abundant liquidity that we've all enjoyed recently. EONIA rates are starting to tick up; given the large negative spread to policy rates, this has encouraged further liquidation in what has been an extremely crowded euribor carry trade.In the US, meanwhile, yesterday's long bond auction showed that dealers are finally appearing to gag a little bit on the smorgasbord of supply that's been on offer from the Treasury. The auction took on a distinctly weaker tone than recent editions; combined with a headline from Bernanke admitting that rates may have to rise at some point in the future (duh!), this has helped catalyze a reversal in US fixed income markets as well.

Said reversal has thus far been orderly, and it's also probably overdue. While the December 2010 eurodollar has made new highs in reent weeks, its momentum has not done so...a divergence that usually signals a tired trend.
So all of this has given the dollar a bit of a boost; after all, in a world of rising rates, the world's nonpareil funding currncy should catch a bit of a short-covering bid. Nevertheless, all of this looks more like position liquidation than a legitimate reversal. Another recently tough-talking CB, the BOK, left rates unchanged a delivered a pretty innocuous statement to boot.

And guess what? The Kospi, the erstwhile mangy dog on Macro Man's equity screen, had a cracking day. The canary in the coal mine has sprung back to life! So while rumblings over stuff like reverse repos from the Fed may cause further jitters, it'll take more than a ten tick sell-off in the reds to entice Macro Man back to a short-risk "investment" strategy (as opposed to a short-term trade.)

Spicy markets are good to trade; however, bitter experience has taught Macro Man that if you try and the whole hog, so to speak, all you generally get left with is a bad case of indigestion.

Good Moaning, Jean-Claude

noreply@blogger.com (Macro Man) — Thu, 08 Oct 2009 08:36:00 +0000

Well, earnings season started with a bang last night as Aloca delivered....errr.....actual earnings. Both operating and GAAP earnigns comfortably exceeded the consensus; while cost-cutting undoubtedly played a major part in the beat, it's also true that top-line revenues actually rose, defying the usual seasonal trend. (2002 was the last year that Q3 revenues exceeded Q2.) At this point, it would probably be churlish to point out that that 9% rise in revenues came in a month when aluminum prices actually rose 14%....

In any event, risk assets have unsurprisingly registered a solid performance overnight, and the DGDF crowd has gone to town in Asia. That trend will come under a bit of scrutiny today when Trichet conducts his post-ECB press conference.

Europe has been unusually vocal in complaining about both the strength of the euro and weakness of the dollar (and its Bretton Woods II parasitic hangers-on), so it will be interesting to see if they are preapred to do anything about it. Yesterday, The Boy Who Cried Wolf evidently produced a report suggesting that Europe is mulling some sort of policy prescription.

At the same time, however, money is draining out of the European money market as the take-up of new tenders has been miniscule. Given that EONIA has traded far, far through the ECB policy rate, this would imply decent upside to euro money-market rates. The euribor curve has started to tick lower, helped by heavy liquidation of call structures, presumbly by a fund well-known to be well-connected in the halls of Frankfurt.

Despite, this, much of the curve is still well higher (i.e., implying lower rates) than was the case just a month ago.
At this point, it's difficult to see the ECB changing policy. The markt (both money markets and equities) are suggesting that further limitless amounts of liquidity aren't really needed. Yet if they try to guide cash rates higher, they might find that the euro goes much further than they would like. Unilateral intervention would likely prove ineffective, and multilateral intervention simply isn't happening. So really, policy on hold and jawboning the euro is the only option open to the ECB at this point.

So when Jean-Claude Trichet opens his press conference by wishing us all a good afternoon, Macro Man plans to reciprocate and wish him a good moaning.

Let's Get Ready To Rumble

noreply@blogger.com (Macro Man) — Wed, 07 Oct 2009 08:24:00 +0000

Alright, let's get ready to rumble. After a few months of "liquidity" being the only fundamental that appear to matter, equities at last start getting some other types of signal as earnings season kicks off with Aloca tonight.

But first, the undercard. Although the story first circulated yesterday afternoon, it's only this morning that the situation in Latvia has started to receive much attention. Essentially, the government is mulling plans to make it easier for homeowners to "DK" their mortgage payments and remove some of the lenders' power of recourse to evict delinquent mortgagees.

This is being interpreted in some quarters as paving the way for a LVL deval; the SEK is modestly weaker as a result. The great irony, of course, is that the bone-crushing recession which has hampered homeowners' ability to finance their mortgages has, at the same time, vastly improved Latvia's current account balance, pictured below. On the face of it, that would appear to forestall the need to devalue in the first place!Other than a little rally in EUR/SEK and Latvian CDS, however, markets have largely shrugged off the Latvian story. The real main event is earnings season, which kicks off after tonight's close when Aloca releases Q3 earnings.

Regular readers may recall that Macro Man threw a hissy fit after the Q2 report, in which Alcoa's accounting department gave their income statement a world-class shiatsu to deliver better than expected operating earnings (while generating worse-than-expected GAAP earnings.) Analysts appear to expect some chance of a return to the massage parlour; according the Bloomberg consensus, GAAP earnings are pegged at -$96 mio while operating earnings are at -$82 mio. (Strangely, GAAP EPS is -0.05 while operating EPS is -0.09. WTF?)

What's more interesting to Macro Man than the ~~lying~~ clever accounting is the expectations management performed by all comapnies in the run-up to their earnings releases. You can clearly see this for Q2; the chart in the upper right hand corner shows how the consensus forecast for AA fell in the few weeks before earnigns were released in July- and this despite a rallying equity markets and green shoots fever!
This quarter might be a bit more of a challenge; as the chart below demonstrates, the consensus has ticked higher over the past several weeks.
Now, Macro Man doesn't know if that holds true for the SPX in aggregate; given the uptick in 2010 earnings estimates, however, he suspects that it does. In that case, Q3 earnings face a substantially higher hurdle than the apparently massaged-lower Q2 consensus.

The naturally bearish conclusion is that disappointment is therefore more likely. By the same token, however, if Q3 earnings do exceed consensus by a comfortable margin, it could set the stage for a slingshot higher into year-end. Macro Man plans on staying nimble and playing the data as it comes.

In any event, we'll know more in 11 hours or so when Alcoa kicks off round one.

Paging Michael Buffer...

"You Suck"

noreply@blogger.com (Macro Man) — Tue, 06 Oct 2009 08:28:00 +0000

Sometimes, markets just scream out "you suck!" Unfortunately, this is one of those times for your humble(d) scribe.

Yesterday, he pointed out that Korean equities had started trading very poorly, no doubt as a reaction to/anticipation of a tightening of monetary conditions and the concomitant impact on the export sector in particular.

Macro Man has kept a special eye on the Kospi in recent weeks, as he has actually had a (long) position in that market, courtesy of a little Asian liquidity model that he's been running. Throughout most of last month it provided a handy offset to his indifferent bearish bets on more developed markets...bets which proved to be rather costly yesterday.

Still, he went to bed last night in a decent mood, confident that the Asian session would rally his long Kospi and offer a tasty bit of payback. Imagine his horror (well, OK, maybe not "horror", but certainly "intense irritation") when he woke up this morning and saw the screen below.
"You suck", indeed.

The resilience of risk assets (other than, y'know, the thing that Macro Man was long) to the first "major" economy tightening, from the RBA last night, has been reasonably impressive. We do seem to be witnessing a little bit of a disconnect, however; the AUD's gone bid on the tightening-no shocker there- but interestingly enough, the back end of the bill strip actually rallied.
Then there's been a faintly ludicrous story from the Independent today, suggesting that oil producers want to move to pricing oil in a currency basket, rather than dollar. After George Washington received a few swift kicks to the groin, the story was roundly denied by the Saudis. Russkies, and UAE. Fun for the whole family!

Still, the buck is looking offered-only and the tide of liquidity seems to be lifting (nearly) all risky boats. Funny, Macro Man could have sworn there was a really crappy US employment figure out on Friday. Hmmph. Must have been a dream.

Markets might be screaming "you suck!" to Macro Man, but trust him: the feeling is mutual.